Treatment of loan guarantees:
International Accounting Standards
UK public accounts
Proposal for an updated SNA93
Jeff Golland, Treasury, UK
International Accounting Standards
Relevant International Accounting Standards
• IA37 “Provisions, Contingent Liabilities and Contingent Assets”
Non-tradable long term guarantees
• IAS39 “Financial instruments: recognition and measurement”
Tradable guarantees, derivatives
• IFRS 4 “Insurance contracts”
Interim standard while fuller guidance is developed
• IPSAS19 “Provisions, Contingent Liabilities and Contingent Assets”
Non-tradable guarantees given by public sector
• IPSAS 9 Revenue from Exchange transactions
Recording fees for guarantees
IAS - International accounting Standard
IFRS - International Financial Reporting Standard
IPSAS – International Public Sector accounting Standard
IPSAS19
Obligations of uncertain timing or amount
(because they depend on future events):
If a payment is probable, a provision is recorded in the balance sheet
If payment is improbable, it is treated as a contingent liability and not
recorded in the balance sheet.
IPSAS19 applies this distinction to the treatment of guarantees.
IPSAS19 based on IAS37. IASB wants to change IAS37 such that all obligations
would be recorded as provisions
The word “Provision”
Used by accountants to mean a liability:
a future expense of uncertain quantity and timing
Used in other contexts to mean a stock of assets
“The squirrel makes provisions for the winter”
Perhaps this is not a problem in other languages
Treatment of guarantees in IPSAS19
• Guarantees are treated as provisions if a call is likely
(typically numerous similar guarantees treating as a group)
• Guarantees are treated as contingent liability and not
recorded in main accounts if a call is not likely (typically
one-off guarantees)
Balance sheet
• Financial liability (a provision) recorded in the balance sheet
= Expected cost of calls on the guarantee (net present value)
• Subsequent movements in the balance sheet arise from:
– Difference between risks expiring and actual claims paid*
– Passage of time unwinding the discount
– Reassessment of risk
• Provision released
– Guarantee payments are redemptions of the liability
* “risks expiring” is the cost of expected calls in the time period when the provision was initially assessed
* sometimes called “provision not required written back”, or “reversed unused during the year”.
Profit & loss account
• Expense recorded in profit and loss account for new provision
= Expected cost of guarantee payments, as in balance sheet
• Expense / income recorded for subsequent movements in the balance
sheet due to
– Difference between risks expiring* calls and actual claims paid
– The passage of time unwinding the discount (expense like interest)
– Any reassessment of future risks
• Provision release is not recorded in P&L account
– Guarantee payments are redemptions of the liability
* “risks expiring” is the cost of expected calls in the time period when the provision
was initially assessed
UK public accounts
UK public accounts
• UK government departments produce annual accounts
according to UK Generally Accepted Accounting Practice (UK
GAAP)
• Financial Reporting Manual (FREM): UK GAP with some
additions for the nature of the public sector
• UK GAAP follows the international accounting standards
• Guarantees are recorded as either provisions or contingent
liabilities depending on whether calls are likely.
Provisions in UK public accounts: examples
•
•
•
•
Clinical negligence
Student loan bad debt
Small firms loan guarantee scheme
Nuclear decommissioning
These liabilities are recorded in the relevant department’s balance
sheet. The amount equals the net present value of expected future
payments. This is a probability weighted concept.
Example of guarantee recorded as a provision
Small firm loan guarantee scheme
P&L account: impact of new guarantees given:
Income: fees charged for new guarantees
Expense: provision recorded for estimated cost of calls on guarantee
If the expected future costs are greater than the fees charged there is
a net cost to the department, recorded in its budget just like real
expenditure.
Contingent liabilities recorded in the notes
to UK public accounts: examples
• Guarantee of loan for Channel Tunnel Rail Link
• Guarantee of loan to Network Rail
Recorded in the notes to the accounts not balance sheet
Amount recorded is the total possible cost.
No impact on department’s budget, unless there is an actual
payment under the guarantee.
Guarantees in UK public accounts
Payment improbable: contingent liability, not in balance sheet
Payment probable: provision recorded
Derivative: record at fair value (credit default swaps)
Export Credit Guarantees: Insurance “fund accounting” is applied,
but this is under review.
System of National Accounts 1993 (SNA93)
System of National Accounts 1993 (SNA93)
Provisions, in the accounting sense, are not recorded.
Consequently, guarantees are not recorded in main accounts, unless
they are traded like financial derivatives
Insurance technical reserves (AF.6), a liability of financial institutions,
are recorded as the value of the assets held to finance future costs,
rather than being an estimate of those future costs. So AF.6 is not
presently recorded like a provision in the accounting sense.
Reasons to change SNA93
• Guarantees are significant
• Giving or selling a guarantee is a transaction
• Harmonisation with accounting standards
• More coherence within SNA by identifying the
counterpart to a payment for a guarantee
Proposals for SNA update
AEG decision July 2005
Distinguish between:
Guarantees that are financial derivatives
no change
- credit default swaps
Standardised guarantees (many of similar type)
new treatment
- student loans
- loans to small businesses
- loans to finance exports
One-off guarantees
-
reroute certain cases ?
loans to state railway companies
Indents are examples, not complete list
Standardised guarantees in an updated SNA93
- Record a liability in the balance sheet of the guarantor
- Value like a provision under IPSAS19
- New instrument F.63 “guarantee provisions”
- Impute subsidies for free guarantees
- Record an asset in balance sheet of lender
AEG meeting in February 2006 will consider some further details explained in paper
circulated by ECB to AEG on 22 November 2005 and subsequent E-discussion
Standardised guarantees in an updated SNA93
The guarantor’s accounts
• Balance sheet: record in AF.63 the amounts recorded under IPSAS19
• Record financial transactions in F.63 for movements in provision
– New guarantee.
• Counterpart receipt of cash for fee.
– Difference between expected calls and actual claims paid
• Counterpart D71 resource: expected calls
• Counterpart D.72 use: claims paid
– Unwinding of the discount
• Counterpart D4: interest
• Record output equal to the fee charged less value of the F.63 liability
• Impute subsidy and extra fee if actual fee insufficient to cover costs
Standardised guarantees in an updated SNA93
Key message
Standardised guarantees are like insurance policies
The logical coherence and economic reality of the methodology
for recording provisions, as in IPSAS19, can be brought into
national accounts by adapting the insurance instruments F6,
D71 and D72.
IPSAS19
Proposed updated SNA
Profit and loss account
Transactions and other flows
Fees received
In calculation of output
Output = fees received1 minus value of financial
liability incurred in F.63
Movement in provisions in P&L account:
of which:
New contracts
Transaction (increase) in F.63 liability, and
transaction (increase) in F.2 asset (the fee paid)
Unwinding of discount
Transaction (increase) in F.63 liability, and
transaction in D.44x (property income)
{ Provision reduced as risks expire
}
{
}
{ Provision increased due to claim paid }
Decrease in F.63 liability, and D.71 insurance
premium receipt
Increases F.63 liability, and D.72 insurance claim
Reassessment of provisions due to other reasons Other volume change K.10 (or add to D.71 ?)
Not in P&L account
Release of provision to pay claim
Decreases AF.63 liability
Decrease in AF.2
Other issues for the recording of guarantees in an
updated SNA93
• Discussed in paper for AGE
– Recording in the accounts of the borrower and lender
– Recording payment of claims when an asset is acquired
• Other issues
– Property income, discount factor to be used
– Accruing premium and output over the life of a guarantee